Tax reform complicates divorce

At least some Republican Senators are getting divorced this year, according to Tom Wheelwright, CPA, founder and president of accounting firm ProVision.

“I guarantee it,” he said. “Why else would they delay the effective date of the alimony provision by one year?”

He is referring to the provision in the Tax Cuts and Jobs Act that eliminates the alimony deduction. Now alimony will no longer be deductible by the payor, and the income will not be taxed to the recipient. With the delay in the effective date – it applies only to divorces entered into after 2018 -- those who are contemplating a divorce or in the middle of one can take steps to make sure that the divorce is final by the end of 2018, thereby retaining the deduction and having a larger pool of funds available to split between the divorcing spouses.

The elimination of the alimony deduction could cause some problems, according to Maria Remillard, a partner at Bowditch & Dewey. “Under the current Tax Code, the deductibility of alimony allows the transfer of money from the spouse who is in a higher tax bracket to the spouse that is in a lower bracket,” she said. “Alimony is typically based on need and the ability to pay, so it allows the practitioner to structure settlements where each party gets a benefit. The payor can deduct the payments, and the recipient will end up getting more money. “

President Donald Trump speaks during a tax bill passage event with Republican congressional members of the House and Senate.
Zach Gibson/Bloomberg

“But under H.R. 1, there will be less money to divide because a majority of the payor’s income will be taxed at a higher rate – the payor can’t shift that liability to the recipient,” she explained. “And when formulating an alimony award, the focus is on the gross income of the parties, because many state alimony laws were enacted with the assumption that any payment would be deductible by the payor and includible in income by the payee.”

Most states have guidelines for structuring alimony awards, she indicated. “In Massachusetts, the statutory guideline is that alimony should be no more than 30 to 35 percent of the party’s income. Under that guideline, the payor could conceivably end up with less net income than the recipient, so either states need to change their alimony rules to recognize the change in the federal law, or every case should have some sort of tax impact analysis to insure that the amount of the award dies not unfairly burden one party or the other.”

“Whenever you have a family unit that separates, the vast majority of individuals will not enjoy the same standard of living once they separate as they did when they lived together, since not only will there be two households to support, it will be with less money available. The theory behind the current system was that by transferring taxes to the recipient, it would keep more income in the family unit. It was a recognition that the family is splitting and now there are two households to support, not one.”

Marc Bello, CPA, a partner at Edelstein & Co., agreed: “In these instances the recipient could end with more disposable income than the payor. Until states change their respective guidelines, a financial person will have to demonstrate to a court that they can no longer use the suggested percentages.”

Bello foresees a push to get divorces finalized before year’s end. “Just for the certainty of knowing what’s coming down the pipeline, there will be an increase to get these agreements done before the year is out,” he said. “Both parties to a divorce would want it, because typically the agreement puts more income in both parties’ pocket than if it were treated as nondeductible support.”

“Although they’re losing disposable income by having alimony nondeductible, there is some gain based on the change in the tax rates,” he said. “It almost has to be done on a case-by-case basis. You have to analyze each divorce to see what the state currently sets, and what it looks like when you make it [alimony] nondeductible, with the goal to equalize the outcome. That’s where CPAs shine.”

“The provision will absolutely reduce what the recipient will get,” said wheelwright.” I would hope that states will make changes to their alimony guidelines. They have a year to do it, but there’s no guarantee that they will.”

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